Recently I have started to see a lot of companies talking about alternative credit data. Naturally, I became curious and wanted to know what is alternative credit data and how does it impact your credit score?
In my research, I discovered that alternative credit data can be a combination of small-dollar installment loans, rental payment history, rent-to-own contracts, point-of-sale financing, cell phone payment history, utility payments, or even verifying your income and assets in real-time.
This method of using credit data from a variety of different sources can have a direct impact on your credit score if the company pulling the data incorporates it into the scoring model.
Is anybody actually using it for lending purposes?
While using alternative credit data has become increasingly popular among some lenders across the United States, it has still not been widely adopted. That is due to the fact that some of the newer scoring models that take it into account have not been completely rolled out yet.
Even then, when new scoring models roll out, lenders are notoriously slow at adopting them.
Some examples of this are the FICO Score XD and the UltraFICO scoring models. Both models include alternative credit data in the scoring model, but neither of them are widely used at this time.
That is not to say that there are not any lenders using data from alternative sources. There are quite a few companies that report this kind of data that are alive and well today. And while it has not yet become mainstream, there are lenders already incorporating the alternative data into their credit scoring models today.
Why it makes sense to include different kinds of data in modern credit scoring models
If a utility bill goes unpaid, that account will ultimately get closed out and sent off to collections. When the account hits collections, it has an immediate negative impact on your credit score.
The utility bill may have been paid every month for the past ten years, but that positive payment history would not have any impact on a credit score.
However, if only $100 gets sent to the collections agency, under current credit scoring models, that would damage the credit score.
That kind of imbalance in credit scoring models is why it makes sense to include alternative credit data in modern credit scoring models.
The history behind it
After the economic crash in 2008, many traditional banks and credit unions stopped offering loans to small businesses. As a result, small businesses had to seek out lending from other sources.
Companies such as Kabbage, QuarterSpot and even Square soon jumped into the mix to fill the lending gap that small business owners suddenly found they had fallen into.
These lenders tended to rely less on the companies credit score profile, and instead, they started to look at the small business’s annual revenue. This allowed them to get a better sense of the companies financial longevity to better determine their ability to repay any debts.
Fast-forward to 2019 and progress towards incorporating alternative credit data has been slow-moving.
But it has been moving.
What started out as more of a small-business endeavor has now morphed into personal credit scoring models, and continues to grow in popularity.
What does the future hold for credit scoring models?
One of the larger companies in the alternative credit data industry is RentBureau. RentBureau was bought by Experian in 2010 and has slowly been incorporated into Experian’s credit reporting toolbox.
By now, you have probably heard of Experian Boost which is an offering by Experian that allows customers to build out more complete credit history by using alternative credit data. Experian Boost appears to be an early result of the RentBureau acquisition.
Experian Boost also includes alternative credit data like insurance payments in their credit scoring algorithms.
As the credit bureaus continue to seek to improve their scoring models and sell products to lenders across the United States, technology and innovation (however slow it may move in the financial industry) will continue moving the lending industry in the direction of using alternative data for modern-day credit scoring models.
For renters, this is actually great news. Chances are rent makes up a big portion of your monthly expenses. However, unlike mortgage payments, you typically don’t get any credit for paying on time. As credit bureaus begin incorporating rent payments as alternative credit data, renters will be able to raise their credit scores and get lower rates on loans when the time comes to buy a property.